Home Equity

WHAT IS HOME EQUITY?

Your home is probably your biggest asset. Because it is an asset, you may be able to borrow money using your home as security. Owning a home is an asset because homes generally increase, or appreciate, in value. As the years go by and you pay your mortgage down, your home equity potentially increases.

Equity is the difference between how much your house is worth and how much you still owe for it. This means you may be able to borrow money using your home as collateral. (Collateral is something you promise to give to a lender if you can’t pay back the loan.) Some reasons you may want to borrow against your home include paying down your high-interest debts, home renovations and paying for other major expenses.

If you do borrow against your home’s equity, be sure to make your home equity payments on time and in full. Otherwise, you may risk losing your home. Use this ability to borrow responsibly, and you’ll have a whole new level of flexibility to achieve your financial goals.

HOME EQUITY LOANS & LINES

Use this chart to compare two different ways of borrowing against the equity in your home.

Home equity loan (Second mortgage)	Home equity line of credit
Provides a lump sum of money Your lender will provide a lump sum.	Provides revolving credit, a type of credit that allows an individual to borrow up to a certain amount of money, repay the money borrowed with interest when it is due, and then borrow the money again.
Uses your home as security Your home secures the loan.	Uses your home as security Your home secures the loan.
Must pay back by certain date Your lender will specify a due date.	Repayment options may vary Your lender will explain your repayment options.
Often used for a project Home equity loans may be used for one specific purpose, like remodeling the house or a wide variety of purposes ranging from home improvements to college education.	Various uses Homeowners use their home equity lines of credit for a wide variety of purposes ranging from home improvements to college education.
Higher interest than first mortgage The interest rate on a second mortgage is usually higher than on a first mortgage. Different financial institutions may offer different rates. Shop around.	Interest rates vary Different financial institutions may offer different rates. Shop around. Some lines of credit have fixed interest rates; others have variable rates.
Tax deductible interest Home equity loans may be tax-deductible if your mortgage debt is within government limits and the borrowed money was used to buy, build, or improve your home. Check with your tax advisor.	Tax deductible interest A home equity line of credit may be tax-deductible if your mortgage debt is within government limits and the borrowed money was used to buy, build, or improve your home. Check with your tax advisor.

BORROWING ON YOUR HOME EQUITY

If you own a home, you may be able to use the equity in your home as a source of financing. Home equity is the financial difference between what your home is worth and the amount of money you still owe as debt on that home. For example, if your home is worth $100,000 and you owe $75,000 on your mortgage, then you have $25,000 of equity in your home.

If you use this ability to borrow wisely, you’ll have a whole new level of flexibility to achieve your financial goals.

Two common ways homeowners borrow against their home’s equity are home equity loans and lines of credit:

Home equity loans are usually installment loans. A loan is an agreement between a borrower and a lender, where the borrower agrees to repay money with interest over a period of time. With an installment loan, the borrower agrees to repay the lender in equal amounts, over a fixed period of time. There can also be other types of home equity loans, such as loans that are interest-only for a time and then have increased payments, or loans with large balloon payments at the end. A home equity loan is secured by your home.

A line of credit is an arrangement where a lender extends a specific amount of credit to a borrower for a certain time period. As long as the borrower repays the principal with interest, he or she can continue to borrow against the line of credit during the agreed upon time period. A line of credit (also called a credit line) can be unsecured or secured. A home equity line of credit is secured by your home.

Some lenders offer flexible payment options and terms on home equity loans and lines, as well as lower interest rates than certain other types of financing. In addition, the interest you pay on a home equity loan or line of credit may be tax deductible. Consult your tax advisor to determine whether any interest you pay may be deducted from your income for federal or state tax purposes.

Like a mortgage, home equity loans and lines of credit use your home as collateral. That means that the lender has a right to sell your home if you don’t repay as agreed. If you borrow against your home’s equity, be sure to make your payments on time and in full. Otherwise, you may risk losing your home.

Two of the most popular uses of home equity financing are home improvements and paying off high interest debts. Paying for major expenses like a wedding, your or your child’s education, and medical expenses are among the many possibilities.

Lenders typically determine how much you can borrow by taking your home’s appraised or fair market value, and subtracting the balances of any outstanding mortgages and liens on the property. In general they will also look at your income and credit to determine how much you can afford to repay.

Many lenders offer home equity loan terms between 5 and 30 years. Many home equity lines of credit have a draw period (the time period in which the borrower may access and use a line of credit) of 10 years. During the draw period, you may be able to apply to renew your line of credit. If you do not renew, you will likely make principal and interest payments for 20 or 30 years, depending on your account balance, to repay what you owe.

Home equity loan payments are generally due monthly. For home equity lines of credit, you will usually receive a bill each month that you carry a balance. Some lenders offer online statements.

For the many home equity loans that are structured like installment loans, your monthly payment stays fixed for the life of the loan and the amount you borrow determines your payment amount. Other kinds of loans may have payments that change over time.

For home equity lines of credit, your minimum payment during the period you access funds (i.e. the draw period) is typically equal to one month’s accrued interest on your outstanding balance, plus any assessed fees (e.g. late fees). After the draw period ends, your repayment period will usually consist of monthly payments of principal and interest.

Borrowing on your home equity is a major decision. Be sure to shop around to compare what’s offered by different lenders, and work with a lender you know and trust.

The information contained herein is being provided as-is and without representation or warranty. The enclosed information is not intended as legal, tax or financial planning advice. Any discussion of tax or accounting matters herein (including any attachments) should not and may not be relied on by any recipient or reader. The recipient/reader should consult their tax adviser, legal consultant and/or accountant for a statement of tax and accounting rules applicable to their particular situation and for all other tax and accounting advice.